ECB set to trim interest rates again: What’s next and why it matters

The European Central Bank (ECB) is poised to cut its deposit rate by 25 basis points to 3% on Thursday, marking the third consecutive reduction in borrowing costs as the eurozone grapples with slowing economic momentum and reduced inflationary pressures. 

While this move is seen as a done deal by market participants, attention will focus on ECB President Christine Lagarde’s guidance on the path forward.

With inflation moderating and economic growth underwhelming, economists and analysts predict the central bank will maintain its easing momentum well into 2025.

How much could the ECB cut interest rates after December?

This week’s cut won’t be the last.

Economists and analysts are nearly unanimous in expecting a 25 basis point cut, with projections pointing towards a further gradual easing cycle into 2025. 

Bank of America expects the ECB to maintain its current pace, cutting rates at every meeting until the deposit rate reaches 1.5% by September 2025. 

“With an economy that will be growing at or below trend for most of 2025, it will be difficult for the ECB to pause rate cuts until the deposit rate drops slightly below its estimate of the neutral level of 2%,” said Bank of America analysts. They added: “At this point, 1.5% is easily becoming an upper bound.”

Danske Bank shares this view, predicting that the ECB will deliver a string of cuts over the next two years, eventually hitting a terminal deposit rate of 1.5%.

Goldman Sachs paints a similar picture, with its baseline scenario forecasting sequential 25bp cuts until the deposit rate reaches 1.75% by July 2025. The investment bank expects the ECB Governing Council to drop statement references on keeping “policy rates sufficiently restrictive for as long as necessary”, and ECB Lagarde to hint at another rate cut in January. 

How could inflation evolve?

Thursday’s meeting will also bring fresh ECB economic projections, which could offer hints about the trajectory of monetary policy. 

ABN Amro expects only minor changes to the ECB’s growth forecasts but anticipates a more significant revision to inflation projections for 2025. “We expect headline inflation for 2025 could see a more meaningful downgrade, with our forecast at 2% compared to the September projection of 2.2%,” said Arjen van Dijkhuizen, senior economist at ABN Amro.

The risk of inflation undershooting the ECB’s target could further justify prolonged rate cuts. Bank of America expects Lagarde to emphasise that the risk of inflation overshooting has diminished, leaving room for policy rates to fall below neutral if economic conditions worsen.

Does the euro face downside risks?

The ECB’s dovish shift could exert downward pressure on the euro, a scenario that some analysts see as likely in the months ahead. Bank of America sees “modestly downside risks for the euro from the meeting and around the ECB’s relative stance in the coming months”.

ING Group’s analyst Chris Turner remains bearish on the euro, and believes that the single currency “is now ready to restart its bear trend should macro and geopolitical inputs allow”.

He added: “This month EUR/USD is staying offered despite a strong seasonal bullish tendency. Typically January and February prove bearish months for EUR/USD.”

How lower interest rates may affect eurozone real economy

Lower interest rates are designed to stimulate economic activity by making borrowing cheaper for households and businesses. In the eurozone, where small and medium enterprises rely heavily on bank loans, cheaper credit could provide a much-needed tailwind for investment. 

For sectors like real estate, the benefits could be highly responsive. Mortgage rates, which have surged in recent years, may ease as central bank cuts ripple through financial markets. This could help revive housing demand, following years of home sales slowing sharply.

Lower borrowing costs may also spur households to spend more on big-ticket items like cars, home improvements, or durable goods, providing a boost to domestic consumption.

A weaker euro, which could follow from the ECB’s dovish stance, further amplifies these effects. As the currency depreciates, eurozone exports become more competitive in global markets, potentially providing a windfall for export-heavy industries like automotive manufacturing, machinery, and chemicals. 

However, the currency’s depreciation is a double-edged sword. While exports may flourish, a weaker euro raises the cost of imported goods, including energy and raw materials. This could partially offset the benefits of lower borrowing costs, particularly for businesses reliant on imported inputs.

However, geopolitical uncertainties, including the ongoing conflicts in Ukraine and the Middle East, as well as looming trade tensions with the United States – particularly the threat of renewed tariffs – pose a clear challenge for European firms.

Businesses may hesitate to invest or expand despite favourable financial conditions, highlighting the limits of monetary policy in an unpredictable global environment.

Ultimately, the ECB’s rate cuts are a crucial tool for supporting economic activity, but their effectiveness will depend on how businesses, consumers, and global markets respond in the months ahead.